5 Market Games For TeachingEconomics

Progression

• 5 Market Games from website economics-games.com• To be played separately or as a sequence:

– Market Game 1: Sunk costs, monopoly, and introduction to the next games

– Market Game 2: Impact of fixed costs and capacity constraints on price and profits, with differentiated goods

– Market Game 3: Impact of the number of competitors on price and profits

– Market Game 4: Price and quantity competition and CO2 environmental policies (quotas, taxes and emission permits)

– (Market Game 2b is a variant of market game 2, with homogenous goods)

• Demand is identical in all of these games (proportionally to the number of players on the markets), except game 2b.

MARKET GAME 1:

SUNK COSTS, MONOPOLY, AND INTRODUCTION TO THE OTHER GAMES

• Very short game (5 minutes), intended to:

– Introduce student to the demand function thatwill be used in the following games.

– Introduce a monopoly benchmark that will beuseful to compare with the competition situations later.

– Have students understand the impact of sunkcosts on the ranking of alternatives.

Objective

Description

• Players are in a monopoly position on 2 identical markets: On each market,

– the marginal cost of production is constant and equal to 4€.

– Players can sell up to 1000 goods on each market.

– What differs is that on the second market, there is a sunk cost equal to 35000€.

• Repeated

Why is this game interesting?

• This game can seem obvious, but it is very effective as an introduction to sunk costs and monopoly pricing.– If players do not realize from the start that the optimal price is

the same on both markets, they will come to understand thiseasily by tatonnement.

– By changing their price by tatonnement from one round to the other, they find themselves in a situation where marginal reasoning is perfectly natural.

– This game provides a monopoly benchmark for later games(monopoly price ~€96, monopoly profit net of sunk costs: ~€40680).

– Even if this is not so fun, players will do it carefully in order to prepare for later multiplayer games and get accustomed to the demand function (provided it does not last too long).

Demand

Price 40 45 50 55 60 65 70 75 80 85 90

Sales (average) 762,02 727,39 694,46 663,34 632,6 603,52 575,3 548,04 521,74 496,55 471,26

Price 95 100 105 110 115 120 125 130 135 140 145

Sales (average) 446,95 423,24 400,1 377,49 355,37 333,63 312,39 291,51 270,74 250,8 231,28

Possible Theoretical debriefings

• Impact of sunk costs on the ranking of alternatives.

• Marginal Revenue, decreasing marginal revenue and marginal cost.

• Illustrates the interest of marginal reasoningthrough the search for the monopoly price(possible debriefing with demand data).

• Cost pass-through (monopoly price with €4 marginal cost is ~€96, revenue maximizingprice is ~€94)

MARKET GAME 2:

IMPACT OF FIXED COSTS AND CAPACITY CONSTRAINTS ON PRICE AND PROFITS (DIFFERENTIATED GOODS)

The interface, Decisions

http://economics-games.com

Objective

• Longer game (25-30 minutes), intended to:

– Explain the logic behind competition.

– Compare oligopoly with monopoly.

– Have students understand the impact of sunkcosts on prices.

– Have students understand the impact of avoidablefixed costs on prices.

– Have students understand the impact of capacityconstraints on prices and profits.

Description

• Players compete against the same other players on 5 identical markets:

• What differs is that on some markets there are avoidable or unavoidable fixed costs, and on others not. Production capacities also differ from one market to another.

• Demand is the same as in game 1 (proportionally to the number of competitors on the markets).

• Repeated game

Description

• Parameters on the 5 different markets:

Marginal Cost Fixed Costs? Capacity constraints

Market 1 4€ No 1000

Market 2 4€ Sunk Costs, 35000€ 1000

Market 3 4€ Sunk Costs, 35000€ 400

Market 4 4€ Sunk Costs, 35000€ 2000

Market 5 4€ Avoidable Costs, 35000€ 1000

Remark 1: Demand

• Demand is based on a logit model. – There is a number of potential customers « arriving » one after the

other on the market, and then considering buying one unit of good to one of the firms that still have something to sell.

– The reservation value of each customer is randomly drawn. Along withanother random draw (to capture unmodeled « horizontal » differences between the goods), this determines who he buys from (if he buys from someone).

• In all our games, in order to facilitate comparison, demand is proportional to the number of firms on the market:– 5 teams on each market5 times as many potential customers as in

the monopoly game presented before.

Remark 2: Parameters calibration

• M 3: Production capacity 400 total production capacity is close to the monopoly quantity.

• M 1, 2, 5: Production capacity 1000

– limits short run competition,

– price remains above the equilibrium price with no capacity constraints, and eventually all firms sell up to their capacity

• M25: The level of fixed cost, €35000 is such that: – If there are 5 or 6 players by market, one or two of them should decide

to stay out of the market 5.

– Profits on markets 2 and 4 will be negative, and the best players cando is to accept that and try and accomodate the situation (and not base their price on average cost!).

Recommended Setting

• Players are split across separate “universes”.

• Players from one universe only interact with other players from the same universe (yet compete with every other player for the highest score)– This is useful to limit over-aggressive strategies

– Balance between competition and cooperation

• Recommended setting: – More than 1 universe

– if possible, 1 universe for 5-6 players

The interface, Results

http://economics-games.com

Possible Theoretical debriefings

• Comparison between monopoly and oligopoly (price and profits).

• What drives competition? – Residual demand and marginal revenue.

– Price elasticity of demand and the sales/margin trade-off

– The prisoner’s dilemma

• Capacity constraints as limits to price competition, keepingprices and profits above the unconstrained level. – First evocation of short run vs long-run competition (more about that

in the last game)

– Analogy « capacity constraints / increasing marginal costs »

Possible Theoretical debriefings

• Impact of sunk cost– on best response functions.

– on equilibrium prices if every player is rational and believes that every otherplayer is rational

more advanced:

– on players’ strategies if they are rational and expect that some of theircompetitors will not be rational and will increase their price

possible discussion about bertrand competition with differentiated goods and capacity constraints, prices as strategic complements, etc.

The role of expectations

possible discussion about what would happen if the process is iterated. Possible presentation of the notion of Nash Equilibrium and discussion about stability of nash equilibria.

Possible Theoretical debriefings

• Impact of avoidable fixed costs– When it does not drive any firm out of the market (=sunk cost)

– When it drives some of the firms out of the market (higher price and profit, but through less competition)

• Price in the short run determined by avoidable costsAND demand AND capacity constraints (and…)

http://economics-games.com

Instructor’s Interface

http://economics-games.com

Instructor’s Interface

More

• More on this game and on how to use the site:

http://economics-games.com/sunk-cost-competition

Possible Extensions to study collusion with market game 2

• Have the students play again with new parameters:

– Anonymous players on some universes, and not on others?

– Encouraging communication or not?

– More or less uncertainty about the end of the game?

– Only allow price changes once every 2 or 3 rounds, on some of the markets?

– On some markets/universes, you can invite students to declare a price on the blackboard (non-bindingdeclaration)

– …

http://economics-games.com

Market game 2b

• Market Game 2b is identical to this game, except that goods are perfectlyhomogenous:– The cheapest firm is the only one to sell, as long

as it has production capacity

– … then the second cheapest firm…

• Same Results with a faster convergence

MARKET GAME 3:

IMPACT OF THE NUMBER OF COMPETITORS ON PRICE AND PROFITS

Objective

• Short game (15 minutes), intended to:

– Explain the logic behind competition

– Compare oligopoly with monopoly

– Have students understand the impact of the number of competitors on the competitionintensity

• Focuses more on these issues, but this is alsocovered by the 2 first games.

Description

• Players compete against other players on 2 markets with a different number of competitors:

• Demand is proportional to the number of competitors.

• Repeated game– Recommended setting: 2-players markets for the first

repartition (i.e. n/2 universes), and 2 big universes with half of the players for the second repartition

– Avoid having only 1 universe to discourage over-aggressive strategies

Possible Theoretical debriefings

• Comparison between monopoly and oligopoly (price and profits).

• What drives competition? – Residual demand and marginal revenue.

– Price elasticity of demand and the sales/unit-price trade-off.

– The prisonner’s dilemma.

• Collusion and repeated games.

MARKET GAME 4:

PRICE AND QUANTITY COMPETITION, AND CO2 ENVIRONMENTAL POLICIES (QUOTAS, TAXES AND EMISSION PERMITS)

Objective

• Longer game (45 minutes-1h), intended to:– Introduce a few basic environmental policy tools: taxes, subsidies,

quotas, permits and explain how/why they work.

– Highlight the importance of marginal reasoning and opportunity costs.

– Have students realize the dangers of misusing average costs.

– Show the impact of marginal cost on price.

– Show how quantity competion in the long-run articulates with pricecompetition in the short-run.

• Can be played after market games 1 and 2, or on its own. – In this case, I would recommend having the students play this game as

a monopoly, first.get accustomed to the demand function.

get accustomed to the environmental policies .

provides a useful benchmark for the multiplayer game

Description

• Impact of environmental policies in a setting with quantity precommitment followed by price competition.

• Players repeatedly take price and quantity decisions on four markets subject to different environmental policies for CO2 emissions: – no policy benchmark, – unit taxes, – quotas – permits

• Production costs and demand are the same on all markets (same as in other games)

• Detailed Rules are available here:http://economics-games.com/resources/site/manual/environmental-economics-games.pdf

Costs and Policies

• Costs:– A firm must pay €15 for each good produced, and then €4 for each good sold.

– Each good produced «emits» 0.5 tons of CO2

• Environmental policies:– Market 1: benchmark market, no environmental policy.

– Market 2: €40 tax by ton of emitted CO2

– Market 3: (non-tradable) quotas, 300 tons of CO2 by round

– Market 4: CO2 emissions permits. Each firm receives 600 permits for free (or 300 permits by round). • With a permit, a firm can emit one ton of CO2 at no cost. • If a firm emits more CO2 than it has permits, it will buy permits at a price of €40 for

each exceeding ton of CO2. • If it emits less CO2 than it has permits, it will sell unused permits at a price of €40

each.

• Remark: for a €40 unit tax, producing 1000 goods costs €(15+0.5*40)*1000, i.e. €35000– If all firms decide to produce 1000 goods, they will find themselves exactly in the

same situation as in market 2 of the second market game.

Possible Theoretical debriefings

• « Average cost of CO2 emissions » vs « marginal costof CO2 emissions ».

• Opportunity costs and emissions reduction subsidies (or permits resale)

• Impact of the 3 environmental policies on CO2

emissions, prices and profits. Differences in practice.

• Windfall profits and quotas.

• …

Possible Theoretical debriefings

• …

• How and to what extent are taxes (or marginal costchanges) passed through to prices. Comparison withthe impact of sunk costs on prices.

• How some variable costs in the long-run turn intosunk costs in the short-run.

– What would happen in the short-run if a sudden, unexpected and severe demand crisis happened?

• Cournot and Bertrand equilibria

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Energy Economics gameCO2 Emissions and Environmental Policies games

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